ECONOMICS >Lira plunges to new lows as Turkey holds rates steady

Turkey's central bank kept its key interest rates steady on Tuesday in the face of a political crisis, sending the local currency plunging to new lows.

The decision had been widely expected after the government ruled out any hike in rates despite the lira's rapid decline since a corruption scandal broke last year.

The bank said after its monthly policy meeting that it was holding its key overnight rate at 7.75 percent, one-week repurchasing or repo rate at 4.5 percent and its borrowing rate at 3.5 percent.

However, the bank's monetary policy committee gave itself room for manoeuvre, saying: "Liquidity policies need to be tightened in order to make the inflation outlook compatible with its medium term targets." The bank said it would make interbank interest rates rise to nine percent on "additional monetary tightening days".

The lira hit a record low of 2.2659 to the dollar and 3.0505 to the euro after the bank announcement but later recovered to 2.2507 against the dollar and 3.0458 to the euro.

The Istanbul stock exchange jumped 1.76 percent on the news to 66,923.38 points. The lira has sunk to new lows almost daily this year as Prime Minister Recep Tayyip Erdogan grapples with the most serious crisis of his 11-year rule and has lost well over 20 percent since May.

The central bank has been under pressure from Erdogan's Islamic-leaning government not to raise interest rates in order to to boost growth and keep inflation in check ahead of key local elections in March.

Instead, it has been using its foreign currency reserves to shore up the currency, selling about $17.6 billion last year.

The lira has been on a sharp downward spiral since mid-December when police launched an anti-corruption probe that has embroiled members of Erdogan's inner circle.

Most analysts had expected the bank to hold fire on any rate increases despite market pressures.

Economy Minister Nihat Zeybekçi on Monday dismissed any likelihood of a hike "because it would be an inconclusive step and put a permanent burden on our economy". Observers said the bank had caved in to government pressure and some speculated that it may be nevertheless forced to hike rates after the March 30 local elections. "Today's move adds to what is already a muddled monetary policy framework and will raise further questions about the credibility of the central bank," London-based Capital Economics said.

"The lira is likely to come under further pressure," it added.

The currency is being pummelled not only from the political crisis but also Turkey's need for cheap funding to cover its external liabilities, making it vulnerable to the US monetary policy tightening.

Economists have highlighted Turkey's yawning current account deficit, currently at over 7.0 percent of gross domestic product, as a key concern.

While the government has insisted its growth target of four percent for 2014 remains intact, many are more pessimistic.

The London-based European Bank for Reconstruction and Development cut its projection for Turkey to 3.3 percent for this year from a previous estimate of 3.6 percent.

"Growth in Turkey is likely to moderate somewhat... reflecting monetary tightening and an increase in financing costs linked to higher political risks which are pulling growth back," the EBRD said.

"Nevertheless, domestic demand is still expected to grow, albeit at a slower pace, and net exports may benefit from a recent depreciation of the currency." Turkey's Deputy Prime Minister Ali Babacan warned last week that inflation might be higher than the 5.3 percent forecast for 2014, compared with 7.4 percent last year.